UK: An Introduction to Family Offices & Funds Structuring

The UK in 2024 continues to provide an excellent opportunity for family offices to set up funds and invest in UK high-growth companies. The environment is attractive, the talent is available, the legislative and policy frameworks are in place and there are plenty of deal opportunities.

The Environment

The UK economic outlook is attractive.

The July 2024 KPMG UK Economy Forecast stated that consumer confidence and consumption was starting to grow again albeit at a modest 0.6 % GDP first quarter 2024, which also resulted in a slight strengthening of sterling. The labour market is tight and real household income is expected to be boosted by 1% following cuts to national insurance contributions. Inflation is falling with interest rates expected to settle at 3.25% by the end of 2025. Household utility bills fell by 12% in April and are set to fall a further 7% in July. Corporate insolvencies are down on a year ago and there appears to be a tentative pick up in M&A.

Now that the election is now over, the Labour government is focused on increasing productivity and growth. Rachel Reeves the Chancellor is on record stating that a Labour government will implement significant interventions into the pensions market to boost investment into UK PLC.

It looks like Labour will go beyond the Mansion House Compact announced by Jeremy Hunt, then Conservative Chancellor, last year which was an agreement by 11 UK pension funds (including Legal and General, Aviva and the Universities Superannuation Scheme) to invest up to 5% of pension assets under management in UK unlisted companies, with a target of GBP50 billion by 2030.

Labour is also reported to be calling for the establishment of a government-backed vehicle for defined contribution pension funds to invest with the state-owned British Business Bank, that would invest in UK growth assets.

The Opportunity

The opportunity is firmly located in the UK life sciences and technology sectors.

We have the talent. A CBRE Life Sciences 2023 UK real estate report referenced in BMS | How will the Mansion House reforms turbocharge investment in… stated that there are now 268,000 people employed in the life sciences sector and over the last five years participation has grown by 10%, which is double the current rate of total employment and CBRE, which is busily engaged in finding lab space, expects the trend to continue at the same rate. Life sciences currently contributes GBP94 billion to the UK economy and that figure looks set to accelerate powered by UK university innovation.

A report by London Economics assessed the contribution of the Russell Group universities research and commercialisation activities to the UK economy as GBP37.6 billion in 2021 and 2022.

Analysis by London Economics showed that the creation of new spin-out companies, wider knowledge exchange and intellectual property licensing across all four nations by the Russell Group universities helped to support 254,000 jobs, twice as many as the chemical and pharmaceutical manufacturing industries combined.

The UK tech industry has also grown tenfold over the last decade employing over 1.7 million people contributing over GBP150 million to the UK economy annually.

There are number of life science and technology companies with good business propositions currently looking to raise capital in a challenging fund raising environment – see BIA Blog: Resilient UK biotech sector lands GBP1.8 billion investment in 2023, which showed that there were no new market launches due to low valuations and investor appetite in the UK.

Family offices with a strong orientation towards venture and direct investing could use the opportunity to invest alongside institutional investors in schemes such as Long-term Investment for Technology and Science (LIFTS) | British Business Bank but also in direct partnerships with the participating pension funds and university innovation committees. (The author of this In-Depth Overview, Rosalyn Breedy, is currently a member of the University of Bristol Innovations committee.)

The recently announced London Stock exchange reforms in relation to a proposed removal of a requirement to hold a shareholder vote on significant related party transactions and the ability for founders and directors to have dual or enhanced voting rights for an unlimited period are also very promising for the opportunity in this sector. It should mean that UK high-growth founders will be more content to list on the London Stock Exchange.

The Risks

The new Labour government has announced plans to tax carry receipts earned by private equity professionals at income tax rates and to charge national insurance. Currently, 45% and 2%, respectively, as opposed to the current 28% capital gains tax regime. They have also committed to strengthening the previous Conservative government’s proposed non-domicile remittance rules.

It is thought by some that experienced private equity professionals and family office investment professionals may leave the UK so that may decrease available investment talent.

The Labour government has started well with a collaborative approach with business and the regional mayors. It appears to recognise that certain infrastructure changes need to be made; however, there is still latent demand by the unions for pay increases and it remains to be seen how the various demands on the public purse will be navigated. Failure to do that well could impact productivity adversely.

The creation of partnerships between government, institutional investors, family offices and universities requires careful alignment of incentives, time horizons and effective governance and reporting frameworks which will take time to develop.

Family offices need to ensure that they negotiate the rights to receive timely financial, operational and sales reports and step in rights on investments as when high-growth companies get into difficulties it happens quickly and unless family offices have the tools to protect their investments such as options to take up board seats and anti-dilution rights they can find substantial value taken away from them.

How Can Family Offices Participate?

Family offices could use this unique opportunity to engage their next generation and invest in accordance with their family values by allocating capital to companies looking to solve climate change and UN Sustainable Development Goals. Much of the innovation in this space is being funded to solve real world problems.

The next generation are often university educated and are part of alumni networks which can help to tap families into the university research networks.

It is imperative that family offices use their unique advantages (long-term investment horizons and ability to assist with commercialisation by helping companies access new markets through network contacts) to court high-growth companies and remain flexible as to how investment deals are structured.

The current private equity structures were developed to assist finance professionals without capital. It looks like there may be exemptions proposed to the application of the new carry regime to investors who put their own capital at real risk. Family offices need to come up with a creative alignment of incentive solutions which properly compensate them for the value of the capital they supply.